On Thursday evening, cloud king Adobe (ADBE) released that firm's fiscal third quarter financial results.
For the three month period ended September 1st, Adobe posted an adjusted EPS of $4.09 (GAAP EPS: $3.05) on revenue of $4.89B. These results beat Wall Street's expectations for the top, adjusted and GAAP bottom lines. The revenue print was good enough for year over year growth of 10.4%.
The lion's share of those adjustments made was for stock based compensation expense (0.98 per share) and for the amortization of intangible assets. This was partially offset by adjustments made for income tax adjustments. Remaining Performance Obligation (RPO) ended the period at $15.72B, up from $15.22B three months earlier.
Operations
As revenue was growing 10.4%, the cost of that revenue increased 6.2% to $580M. This left a gross profit of $4.31B (+10.9%), as gross margin increased from 87.7% to 88.1%. GAAP operating expenses increased 8.7% to $2.613B leaving operating income of $1.697B (+14.4%) on an operating margin of 34.7%, up from 33.5%.
Once adjusted, operating income becomes $2.264B (+15.8%) and operating margin becomes 46.3%, up from 44.1%. After accounting for interest and taxes, Adobe was left with a GAAP net income of $1.403B (+23.5%)
Segment Performance
- Digital Media generated revenue of $3.59B, up 11%, or 14% in constant currency (cc).
- Creative generated revenue of $2.91B, up 11%, or 14% in cc.
- Document Cloud generated revenue of $685M, up 13%, or 15% in cc.
- Digital Media ARR (annual recurring revenue) reached $14.6B on new growth of $464M.
- Creative ARR grew to $11.97B.
- Document Cloud ARR grew to $2.63B.
- Digital Experience generated revenue of $1.23B, up 10%, or 11% in constant currency.
- Digital Experience subscription revenue was $1.1B, up 12%, or 13% in cc.
Fundamentals
For the quarter, Adobe generated operating free cash flow of $1.873B. Out of this came just $91M worth of CapEx spending. This leaves free cash flow of $1.782B. Adobe does not pay shareholders a cash dividend, but the firm did repurchase $1B worth of common stock for the firm's treasury. The balance went towards the balance sheet.
Turning to that balance sheet, we see that the firm's cash position has grown to $7.516B, which is up 23.3% over the first nine months of the firm's fiscal year. That brings current assets up to $10.41B. Current liabilities add up to $8.334B. This includes no short-term debt, and most of this number is labeled as deferred revenue. The firm's current ratio stands at a healthy enough 1.25. However, once omitting deferred revenues as those are not true financial liabilities, this "adjusted" ratio stands at an absolute beastly 3.52.
Total assets amount to $29.09B and include $13.967B in goodwill and other intangibles. At 48% of total assets, I think that's a bit much, but this doesn't really impact the strength of the balance sheet. Total liabilities less equity comes to $13.314B, including $3.633B worth of long-term debt, which was primarily borrowed at lower interest rates and could be paid for out of pocket if need me.
Guidance
Guidance was provided both in the press release and during the call, but not until CFO Dan Durn finally got his chance to speak. He was the fourth representative of the firm to speak at the call and he offered up his current quarter outlook rather late during his spiel.
For the fiscal fourth (current) quarter, Adobe is targeting revenue of $4.975B to $5.025B. This envelops the $5B or so that Wall Street was looking for. The firm sees Digital Media net new ARR of roughly $520M and digital Media segment revenue of $3.67B to $3.7B. Digital Experience segment revenue is seen at $1.25B to $1.27B, with Digital Experience subscription revenue printing at $1.11B to $1.13B.
The firm sees GAAP EPS at $3.10 to $3.15 and adjusted EPS at $4.10 to $41.5. Wall Street was looking for EPS guidance of about $4.05, so this is a solid beat.
Wall Street
Since these earnings were released on Thursday evening, I have come across 15 sell-side analysts that are both rated at a minimum of four stars at TipRanks and have also opined on ADBE. Among the 15 analysts, we have 10 "buy" or buy-equivalent ratings and five "hold" or hold-equivalent ratings. One of the holds did not set a target price, so we are left working with 14 targets.
The average target price across these 14 analysts is $617.86 with a high of $660 twice (Keith Weiss of Morgan Stanley and Bradley Skills of Bank of America) and a low of $500 (Gil Luria of DA Davidson). Once omitting one of those highs and the low, the average across the other 12 rises to $624.17. For those seeking more granularity, the average buy rated target came to and even $636, while the average hold rated target stood at $572.50.
My Thoughts
Adobe is a great company. No doubt about it. Beating expectations, beating guidance, generating robust operating and free cash flows, and steadily rising recurring revenues. The only truly negative thing to say about this stock is that it is trading at 35 times forward looking earnings and growing earnings at 10% on a year over year basis regularly.
The quarter just reported was the firms' fourth consecutive quarter growing revenue by 10% or within a percentage point of 10% on an annual basis. In fact, Adobe has not grown revenue by more than 14% since Q4 2021. Does this kind of growth deserve a 35 times multiple? I think the market is telling us what it thinks with the stock recently down more than 4%.
It is imperative for shareholders of ADBE that the stock hang on to that 50 day SMA (simple moving average) at $520 into the weekend. This is the $528 level, which is precisely where the stock is trading as I write. Relative strength is weakening. The daily MACD (moving average convergence divergence) has just experienced a bearish crossunder by the 12 day EMA (exponential moving average) through the 26 day EMA as the histogram of the nine day EMA has gone negative. These are all bearish looking indicators.
Should the stock not hold the 50 day line, there is potential for a significant selloff given how profound the rally has been from October 2022 into the present and really how almost parabolic that rally had been starting with this past May. The first area of support would show its face at a 31.8% Fibonacci retracement of the entire rally. That's $456. The 200 day SMA is all the way down at $413.
The stock does not have to lose all of that ground, but it surely does not have to hold at these levels when it is clear, the company has evolved, due to its size, from a growth stock into a cash flow producing beast. I'm not going to call Adobe an Industrial because its balance sheet is too solid and it does not have to worry about inventories, but it's no longer a growth stock and needs to be valued accordingly.
A cautious investor could get long an October 20th $520/$500 bear put spread for a net debit of $6.30. That's buying $520 October 20th ADBE puts and selling a like amount of $500 October 20th ADBE $500 puts. The investor is risking $6.30 in an attempt to win back $20. That's a 217% profit if it works.